Clayton Williams Energy
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Background:
Clayton Williams Energy Inc. is an independent oil and gas company engaged in the exploration, development, and production of oil and natural gas primarily in Texas, Louisiana, and New Mexico. The company's common stock trades on the NASDAQ National Market under the ticker symbol "CWEI".
Strengths:
Clayton Williams' balance sheet is one of the strongest in the industry. For the trailing twelve months (TTM), the company's EBITDAX-to-interest ratio and EBITDAX-to-fixed charges ratio are 23.9x and 20.1x, respectively. These figures are more than double the average for the company's peer group. In addition, Clayton Williams has generated approximately $64.8 million in EBITDAX (TTM), which exceeds the company's total debt (as of September 30, 2000) by 240 percent. The company's peer group, on average, has only generated EBITDAX sufficient to cover 79 percent of total debt.
The company's capital structure is very sound as well. As of September 30, 2000, Clayton Williams' total debt as a percentage of tangible net worth, tangible assets, and total capital was 32.3 percent, 17.6 percent, and 24.4 percent, respectively, compared to a peer group average of 81.1 percent, 35.3 percent, and 44.8 percent, respectively.
Part of the reason for Clayton Williams' low debt level is the vendor financing arrangements that the company has taken advantage of. The vendor arrangements are a form of off-balance sheet financing which allow the company to pay for drilling services through future production. Clayton Williams set up the vendor program in early 1999 when product prices were low and little relief was in sight. Since the company hedged 87 percent of its 1998 oil production at $19.61/barrel, Clayton Williams was in good shape given the relative condition of the industry at the time. As a result, Clayton Williams was one of the few companies that had the money or economic prospects to drill at 1999 oil prices. These financing arrangements allowed the company to keep debt down and spread cash flow to as many projects as possible.
Currently, Clayton Williams receives approximately 40 percent of the cash flow (net of royalty interest) from its Cotton Valley reef wells, while vendors receive 60 percent. The company, however, anticipates that the entire vendor program, which consists of $8 million of off-balance sheet financing, will be paid out by the second half of 2001. Once this occurs, Clayton Williams will own 100 percent of the cash flow and reserves (net of royalty interest) associated with these wells. If the company gets a boost from natural gas prices, as well as solid production from its McGrew #1 and Muse #1 wells, the pay out could be completed much sooner.
Over the past twelve months, the company has also been able to fund its capital expenditures (capex) through operating cash flow. By budgeting within its cash flow, the company has been able to generate $8.6 million in free cash flow. This excess cash has been used to pay down debt and may be used towards future stock repurchases as well. For the trailing twelve months, Clayton Williams' operating cash flow as a percentage of total debt and capex are 222.4 percent and 116.7 percent, respectively, versus a peer group average of 62.9 percent and 81.1 percent, respectively. In other words, most companies in Clayton Williams' peer group, on average, have not been able to generate sufficient cash flow to fully fund their capex budget. Clayton Williams also plans to fund its 2001 capex budget through cash flow. Furthermore, the company has $23 million available under its credit facility if necessary.
The company's ability to add quality reserves and keep costs at a minimum is advantageous as well. Clayton Williams' Performance Value Index (PVI) was 1.4x for 1999. This means that the PV-10 of the company's discovered reserves in 1999 was 40 percent greater than the costs of finding and developing those reserves. In other words, Clayton Williams was able to create $1.40 in value for every $1.00 in capital expenditures. In addition, the company has a ceiling test ratio of 2.0x, which means that the PV-10 of the company's reserves at 1999 year-end (pre-tax) was nearly twice the amount of the company's net capitalized costs. This gives the company significant cushion if commodity prices take a downturn in the near future (as impairment charges or write-down of assets will be unlikely). This also means that the company has been adding reserves over the years at relatively inexpensive prices. Furthermore, nearly 80 percent of Clayton Williams' reserves are proven developed and the company has a 79 percent net working interest in its properties. This translates to greater cost control.
Weaknesses:
The company recently reported that net reserves from its J.C. Fazzino wells (#1 and #2) had been revised downward. The two wells, which produce from the Cotton Valley reef, are now estimated to hold 8.5 Bcf of natural gas (net of royalties and vendor financing arrangements) as opposed to 11.2 Bcf as of December 31, 1999. The downward revision is due to the fact that the decline in flowing tubing pressure has yet to level off for these wells. Since the two wells have seen only slight leveling at best, the company can not guarantee that current reserve numbers will not be written down again.
This leads to another problem for Clayton Williams. Given the steep decline rates associated with the Cotton Valley reef wells, the company will have to focus its attention on finding longer life reserves to help replace production. This will likely come from the company's New Mexico or Louisiana properties. In addition, the company replaced 276 percent of its annual production in 1999. Excluding revisions though, Clayton Williams only replaced 82 percent of its annual production in 1999. Furthermore, because such a large portion of the company's added reserves were due to revisions (as opposed to actual drilling discoveries or extensions), Clayton Williams had replacement costs of $6.85 (per BOE) in 1999, which was slightly higher than the peer group average of $6.70.
Valuation:
Part of the reason for the recent drop in Clayton Williams' stock price is likely due to the unexpected expenses that the company incurred in the third quarter of 2000. The company not only had a $1.6 million income tax provision, the first ever recorded in its public history, but a $2.2 million non-cash charge for stock-based compensation as well. Both of these items caught analysts and investors off guard. Along with the downward revision in reserves, the stock took a turn for the worse. Clayton Williams' stock closed at $21.50 on December 15, 2000, more than 50 percent off its 52-week high.
Though this was likely an overreaction by investors, other concerns still remain. For example, Clayton Williams has spent $8 million on its south Louisiana properties this year, with another $9 million expected to be spent in the fourth quarter of 2000. Despite the large investment in this area, the company has yet to offer any insight on these developments to the public. With a significant portion of the company's capex going into these properties but little information to go on, investors are being left in the dark. As a result, additional risk is being placed on the company.
Currently, Clayton Williams is trading at an Enterprise Value/EBITDAX ratio and an Enterprise Value/Operating Cash Flow ratio of 3.5x and 3.7x, respectively, versus a peer group average of 4.5x and 5.7x, respectively. Given the uncertainties surrounding the company though, these lower multiples may be warranted. Though the stock is attractive at current levels, investors should allow some time for further developments to unfold. Once there is more certainty and visibility regarding the company's future, additional evaluation and analysis will be provided.
Disclaimer:
This report and the information contained herein is strictly the opinion of the publisher and is intended for informational purposes only. Readers are encouraged to do their own research and due diligence before making any investment decision. The publisher will not be held liable for any actions taken by the reader. Although the information in this report has been obtained from resources that the publisher believes to be reliable, the publisher does not guarantee its accuracy. Please note that the publisher may take positions in companies profiled.
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